Everything You Wanted to Know About Cryptocurrency Derivatives

A crypto derivative is a contract or product whose price is determined by an underlying asset such as commodities, stocks, exchange rates, currencies and interest rates. This mechanism allows buyers and sellers to bet on the future value of the underlying asset to make a profit.

This article explores all the basics of crypto derivatives and derivatives trading so you can be better informed.

Derivatives trading – the rudimentary concept

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In derivatives trading, the underlying asset can be any cryptocurrency token where buyers and sellers enter into a financial contract. This contract speculates on the price of crypto at a future date.

• During the first phase, the contract allows both parties to agree on a sale/purchase price of the crypto token on a specific day. This price is independent of the market price and is not influenced by the associated fluctuations.
• As a result, investors can take advantage of an underlying’s price movements in two ways. They can buy cheaper or sell more expensive.

Where to trade derivatives?

You can trade crypto token derivatives on centralized exchanges. In addition, most decentralized exchanges allow this type of trading. These derivatives trading platforms are much more flexible than any spot margin trade giving you access to different otherwise unfamiliar markets.

Types of Crypto Derivatives – Most Preferred Options on the Market

Depending on the original terms of a contract, crypto derivatives can be one of the following types.

Forward contracts: The futures contract is a legal agreement between the buyer and seller. It involves buying or selling an underlying asset at a predetermined price and date in the future.
Choice : Options give the trader a choice but take away the responsibility to buy or sell the underlying asset at a specified value at the future date and price.
Perpetual contracts: A perpetual contract, unlike futures or options, has no expiration date or settlement. Under certain circumstances, traders open their positions to trade indefinitely.
Trade : A swap is a contract to exchange cash flows at a future date using a predetermined formula. These are over-the-counter (OTC) contracts and are not traded on regulated exchanges.
ahead: A futures contract is a derivative that uses a non-standardized contract to trade the underlying asset at a future time and price.

Essential Features of Derivatives Trading

#1. Stop/Loss Taking Profit:
Stop/Loss take profit is a mechanism that allows traders to specify floor and ceiling values ​​for a particular order. As a result, they can automatically exit the market when conditions become profitable.
#2. Automatic debt reduction (ADL):
A crypto exchange’s ADL system automatically uses an opposing position from a nominated trader when a position cannot be liquidated at a price above the break-in price. ADL also works if the insurance is insufficient to cover the damage as a result of the contract.
#3. Partial closing orders:
This feature allows traders to make partial profits by partially closing their orders while continuing to earn consistent profits in the growing market.

Advantages of derivatives

Reduced transaction costs: In general, derivatives are risk management tools and therefore they have lower transaction costs in the market unlike other securities such as spot trading.
Risk management: The price of the crypto token value has a relationship with the contract value. For this reason, traders use these derivatives to mitigate the risks associated with fluctuations in the prices of the underlying assets. Moreover, this risk is transferable to others.
Efficient: The practice of arbitrage in derivative contracts ensures that the market finds equilibrium once the price of the underlying asset is correct.

Disadvantages of Using Derivatives

Highly speculative: There is no denying that derivative contracts work best as speculative instruments. This risky nature makes the process unpredictable and leads to heavy losses.
The risk element is heavy: While derivatives help reduce the risk of price swings in the underlying crypto tokens, they are undoubtedly highly volatile. This happens because of the fluctuating value of the crypto tokens after the contract is closed, which is at the expense of the trader’s money.

Final Thoughts – The Future of the Derivatives Market

According to experts, the crypto derivatives market is witnessing an increase in trading volume in the coming years. In the third quarter of 2020, trading volume was approximately $2.7 trillion, up 25.1% from the previous quarter. This massive growth will become evident in 2022 as the market continues to grow and traders around the world are involved.

Also read: Getting Started in the Cryptoverse: What You Need to Know

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